Arista Networks (ANET -0.02%) made its name as an innovator of networking equipment (specifically switches) for data centers. These days, the scrappy growth company is so much more -- and its relevance is only rising as artificial intelligence (AI) transforms what data centers do and how they're built. This trend is showing up in Arista's financials.
To be clear, Arista is no value stock, but that isn't a new development. If you're looking for a top way to bet on cloud-based AI, and data centers in general, for the long term, Arista Networks needs to be on your radar.
An upgrade to 2023 and rosy comments on 2024
I started researching and investing in Arista Networks during the second half of the 2010s. The company was exiting its early growth period and transforming from a provider of those switches and routers (critical hardware that controls the flow of data moved within and between data centers, both for public and private company use) into more of a platform.
Today, while the bulk of Arista's sales do come from hardware, and typically a mid-teens percentage each quarter from software and services, think of this business as more of an engineering partner that cloud computing companies tap when building or updating a data center.
As such, Arista is at the forefront of the current AI movement. Housed in a data center -- far behind the scenes of the internet-delivered apps and services we access every day at work and home -- are powerful computing units called servers. These servers are used to build and operate all the digital services we rely on.
However, AI is necessitating a big change in how these clusters of servers are built and operate with each other. Some of the new AI that has gone viral -- generative AI like ChatGPT, for example, powered by algorithms like large language models -- requires servers that can "train" the AI model. These servers are predominantly powered by graphics processing units (GPUs; mostly Nvidia's and are networked together with high throughput chips from companies like Broadcom and Marvell Technology Group.
Arista relies on chip suppliers like these in designing its routers and switches and when designing a data center architecture for use by its end customers. And it has added some critical software infrastructure management tools to its suite in recent years to make its platform easier to use.
Because it sits at this juncture between basic chips and components and data center operator, Arista carved out a sticky, critical niche in the world of IT. It's already enjoyed fast, steady growth for many years, as well as high and rising profit margins. Everyone's suddenly insatiable desire for this new breed of AI has only kept the good times rolling.
Arista upgraded its full-year 2023 revenue growth expectation from 25% last quarter (during the Q2 update) to 33%. And though it hasn't provided specific guidance yet, it expects double-digit percentage growth again in 2024 and for the long term.
Data by YCharts. TTM = trailing 12 months.
The best AI bet despite high valuation?
The most common objection that comes up with Arista Networks' stock -- at least in my experience -- isn't growth and long-term expansion opportunities, but rather valuation. Indeed, even after a knockout year like the company has had through the first nine months of 2023, where earnings per share (EPS) have grown 60% compared to 2022, shares trade for 37 times trailing 12-month EPS. The stock trades for about 28 times Wall Street analysts' consensus expectation for 2024 EPS.
There's no other way to slice it: Arista carries a premium price tag, and it always has. And with that comes some wild swings in stock price.
Valuation has compressed a bit at times, offering a lucrative entry point for investors waiting for a sharp pullback. But those have come in times of heightened uncertainty, like during the onset of the U.S.-China trade war in 2018-2019 and early in the pandemic when chip supplies were inadequate to get data center projects done in a timely fashion. In times like those, worry tends to flip from the "valuation is too high" argument to the "valuation isn't cheap enough because Arista's run is coming to an end" concern.
And, yet, every cycle, Arista's customers keep coming back to spend on more data centers and increasingly complex engineering.
Investors interested in owning a slice of this company may simply have to stomach that high price tag and ride out the volatility -- if you think data centers will remain a top growth trend over the next decade-plus. One way to mitigate the worry that comes with buying a premium-valued company is to use a dollar-cost average plan, building a larger position over time and consistently buying during peaks and dips in stock price.
At any rate, Arista has a lot to gain as its thousands of customers upgrade the back-ends of their cloud environments for AI and, later on, to the front end of their cloud data centers as new AI-powered apps fully come to bear. Though shares don't look as timely a buy as earlier this year, I'm optimistic about Arista's potential for the duration of the 2020s and beyond.
